Outside the Box: Restricted stock units can be a building block for retirement savings

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In a bygone era, employees followed a fairly standard path to retirement using a combination of Social Security benefits and company pension plans.

Over time, pensions gave way to 401(k)s and IRAs — all vehicles for long-term wealth building that are essentially untouchable until your golden years.

Today, a type of equity compensation called restricted stock units (RSUs) offers a new building block toward retirement, while also opening doors for investments, experiences and major purchases throughout the course of your life.

RSUs have the potential to be used in multiple ways to help you achieve your financial goals. In addition to possibly providing valuable assets for a retirement portfolio, RSUs can also play a role in how you manage your cash flow and credit liabilities, and even help in hitting financial milestones that you might have thought would be out of reach until much later. For some, that might mean extensive international travel. Where I’m from in Seattle, it might also mean a cabin on an island like the one your grandparents owned when you were a kid.

What is emerging with the growth of RSUs is a new way to look at portfolio management, retirement planning and investment structures, with the ultimate benefit of flexibility.

RSU basics

Popular in the tech industry, but more commonly available at companies in a range of industries, RSUs are offered to employees as part of their total compensation, alongside the typical package of salary, bonus, health benefits and more. Technically speaking, RSUs represent a contractual right to receive company shares or cash payment in the future. RSUs will “vest” at a predetermined date, such as a year, or commonly over three to four years, from the date of hire. That vesting date is when the employee takes ownership of these shares and can make decisions about how to use them. Each additional grant of RSUs has its own vesting schedule, so the more grants you (hopefully) receive, the more complicated it is to keep track of.

RSUs and credit

Most people are familiar with the idea of a home equity line of credit. What you might not know is that you can create your own line of credit from a taxable account with the help of RSUs. In other words, just like you can borrow against the value of your real estate, you can borrow against your vested shares with a flexible line of credit.

You might go this route to finance a down payment on a home, make a tuition payment for yourself or a child, pay for a wedding, or cover another major event or expense.

Rather than having to sell your stock, especially at a down point in the market, or putting those big-ticket items on your credit card at a high interest rate, you can borrow against your own assets and spread out the payments over time. Best of all, the interest rate may be substantially lower than that of other types of credit.

Let’s take that idea one step further. You might think selling RSUs to buy a home would be a simple exchange from one asset into another. But it is well worth considering all of the cash management possibilities here. With home loan rates still lingering at historic lows, around 3%, why sell RSUs that may appreciate and have to pay a capital-gains tax on top? Instead, you might choose to access your line of credit for the down payment, and use a home loan, taking advantage of writing off the interest on your taxes. This way you hang onto the RSUs and realize their value over time via a line of credit to invest in or buy/pay for something else. In this way, an often overlooked value of RSUs is how they open different avenues for managing your cash, credit and investment options in concert with one another.

This added flexibility is especially valuable in light of some of the more traditional ways you might be building wealth, like an IRA or 401(k) account. Not only are these inaccessible without significant tax consequences until retirement age, but you also typically cannot borrow against the money in these accounts.

RSUs and taxes

While I’ve been extolling the virtues of RSUs, it’s important to acknowledge that related tax issues can be tricky if they haven’t been fully explained. For example, employees are often surprised that vested RSUs are treated and taxed as ordinary income in the tax year they vest.

Another surprise may come if you sell your shares within a year of them vesting. Any gains are considered short-term and are thus taxed as ordinary (earned) income—much higher than if you hold the shares for a year or more before selling. At that point, you’re into long-term capital gains territory and will only be taxed 20% on the realized gains.

For tax reasons, and in general, it’s important to understand what’s called the cost basis, or the original value, of your RSUs. Many recipients of RSUs don’t realize that the day their shares vest is the day the cost basis is set. It’s common for individual employees, personal accountants or even the company itself to record a zero cost basis, thinking of the shares as a gift. Later, the employee incorrectly pays taxes on the RSUs as a zero-value asset, a mistake that can really cost them come tax time, since they should have paid taxes on the actual value of the assets on the date vested.

Understanding this from the outset, and knowing how sales of RSUs are treated for tax purposes, can help you avoid surprise tax bills and strategically plan out your tax liabilities.

RSUs and your wealth

Once your RSU shares have vested, you own them. That means you can move them to another institution for safekeeping and/or to streamline your assets, cash them out, save them or give them as a gift. Consolidating your assets can help you and your financial adviser keep track of your important dates related to vesting and taxes, how they play into your personal financial plan, and the best plan of action for you personally.

If you’re already fortunate enough to receive RSUs, be sure you understand all the ways they can help you achieve your short- and long-term financial goals. If you’re looking to make a career move, I’d encourage you to consider companies that offer stock as part of their compensation package.

Used to their full potential, RSUs can open up a world of possibilities in the present and still enable saving for the future.

Heather Krause is senior vice president, financial adviser and assistant branch director, RBC Wealth Management – U.S.

Securities-based loans involve special risks and are not suitable for everyone. You should review the provisions of any agreement and related disclosures, and consult with your own independent tax and legal advisors about any questions you have prior to using securities-based loans or lines of credit. Additional restrictions may apply.

RBC Wealth Management, a division of RBC Capital Markets, LLC, is a registered Broker-Dealer, Member FINRA/NYSE/SIPC, and is not a bank. RBC Capital Markets, LLC, its affiliates and their employees do not provide tax or legal advice. Lending services may be offered by bank affiliates of RBC Wealth Management. RBC Wealth Management and/or your financial advisor may receive compensation in conjunction with offering or referring these services.